Impact on growth company behaviour
Company managers are recognising that the current environment of increased uncertainty, macro volatility and rising cost of capital could persist for some time. Accordingly, we are seeing renewed emphasis on building companies with strong foundations and spending wisely in order to achieve sustainable growth.
For example, some companies are focusing on reaching profitability earlier to mitigate against the volatile macroeconomic backdrop. Well-funded businesses with supportive investors tend be more opportunistic in challenging conditions, which can be seen in several companies looking for potential value-accretive acquisitions. In addition, firms that are financially comfortable tend to have more scope to explore organic growth opportunities.
Adversity - a driver of innovation
The old adage of ‘adversity is the mother of invention’ has many instances in the corporate world. And consistent with this, amid recent challenges such as the Covid pandemic, there’s been an acceleration of some existing disruptive industry trends.
In this respect, the current context of supply chain pressures and high inflation is an opportunity for companies that can help address these issues. Take software penetration in Europe, which for a long time has lagged behind the US. Here, increasing software investment could help to close this gap and lower inflation over the long run. Likewise, current soaring energy and food prices can act as drivers of innovation in these sectors.
Funding conditions and investor behaviour
Increased uncertainty, market volatility and higher capital costs have definitely made the private equity funding environment more challenging. Interestingly, there is actually no shortage of capital available to be deployed, but we are seeing investors acting more cautiously in light of the new conditions. Many are taking more time to complete due diligence work. This includes assessing whether potential investee companies are sufficiently well equipped to withstand current headwinds, such as significantly higher input costs.
“…there is actually no shortage of capital available to be deployed, but we are seeing investors acting more cautiously in light of the new conditions.”
More generally, good company fundamentals are more prized than ever. This includes greater focus on pro-resilience credentials such as pricing power, customer loyalty and products that genuinely solve problems. At the same time, investors understand that corporates that can comfortably survive tough macro and market volatility conditions can really flourish in more ‘normal’ or favourable conditions. The skill, as ever, is to find these companies.
Sustainability considerations
In terms of ESG and sustainability factors, as in other major asset classes, these considerations continue to gain importance in growth companies’ and private capital investors’ decision-making. Certainly, the more difficult macro and financial backdrop appears not have lessened this trend.
At abrdn, our long-held core belief across all asset classes is that businesses with good sustainability credentials also tend to be better investments. In this context, we have been pleased to see that more growth companies themselves are evaluating the ESG credentials of potential capital providers.
Some advantages for private capital
The current market environment is certainly testing in many ways. Nonetheless, there are also positive aspects for private equity investors and private capital more broadly. With public markets essentially closed for IPOs, the number of funding opportunities could grow for other capital suppliers. In addition, in current tough conditions, it tends to be harder for private investors to exit companies. This can potentially entail more opportunities for other private investors looking to deploy new capital.
Looking ahead, we envisage more companies remaining private for longer given the obstacles associated with becoming public. Venture debt and growth debt is also becoming increasingly attractive in the present demanding valuation environment.
Final thoughts…
The tough economic conditions of late, including high inflation and rising interest rates, have resulted in a correction in most public markets. Private markets have not been immune to this. Funding conditions are noticeably tighter and market participants are treading more cautiously. However, we are also seeing that the adverse backdrop is creating new opportunities for a number of growth companies and private capital suppliers.